Termination Payment Tax Advice
Support with the tax treatment of termination payments, settlement agreements, PILON and post-employment notice pay.
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Different payments have different tax rules
When an employee leaves a business, the tax position can be more complex than it first appears. A termination payment may include several different elements, and each part can be treated differently for income tax, National Insurance and wider payroll reporting.
At Chartergates, we help employers, directors and advisers understand the correct tax treatment of payments made on the termination of employment. This includes reviewing settlement terms, identifying taxable payments and advising on whether any part of a lump sum can be paid tax free.
The rules changed significantly from April 2018, especially for notice pay and payment in lieu of notice (PILON) arrangements. Since April 2020, employer Class 1A National Insurance can also apply in real time to termination awards above £30,000.
The exemption does not apply to every payment.
Final salary, holiday pay, bonuses, contractual benefits, commission and other amounts already earned are normally treated as taxable employment income.
How Chartergates can help
We advise employers, employees and professional advisers on the tax treatment of termination payments, from early-stage review through to HMRC correspondence.
Payment in Lieu of Notice
Advice on contractual and non-contractual PILON arrangements and their treatment as taxable earnings.
Post-Employment Notice Pay
Support with PENP calculations, including notice periods, variable pay, instalments and mixed payment packages.
The £30,000 Exemption
Identify genuine compensation payments that may qualify and separate them from taxable earnings.
Redundancy Payments
Review statutory and enhanced redundancy packages and determine how the exemption may apply.
Settlement Agreements
Separate compensation, notice pay, holiday pay, bonuses, benefits and legal costs clearly and correctly.
Restrictive Covenants
Clarify the tax treatment of payments linked to post-employment restrictions and other taxable amounts.
Advice before the payment is made
Review the arrangement
We examine the employment contract, notice terms, proposed agreement and the reason for termination.
Separate each payment
The package is divided into taxable earnings, notice pay, compensation, redundancy and any additional sums.
Calculate the treatment
We assess income tax, National Insurance, PENP and the potential application of the £30,000 exemption.
Provide clear advice
You receive practical recommendations for finalising the agreement and processing the payment.
Why professional advice matters
Termination payment rules are technical. Employers need to consider the employment contract, the notice period, the reason for termination, the structure of the settlement agreement and the correct PENP calculation.
Where the tax treatment is wrong, HMRC may challenge the employer. This can result in unpaid tax, National Insurance liabilities, interest and penalties.
Clear advice before payment is made
At Chartergates, we provide clear advice on the tax treatment of termination payments before the payment is made. We can review the proposed package, identify which elements are subject to tax, calculate the correct treatment of PILON and PENP, and advise on whether the £30,000 exemption is available.
Payment in Lieu of Notice (PILON)
What is a PILON?
A payment in lieu of notice (PILON) is a payment made instead of requiring the employee to work their notice period. It may be provided for in the employment contract, or it may be agreed as part of an exit arrangement.
Historically, the tax treatment of PILONs could depend on whether there was a contractual PILON clause. However, the rules changed from April 2018, and the position is now more structured.
Contractual PILONs and non-contractual PILONs
Contractual PILONs are generally treated as taxable earnings. This means they are subject to income tax and National Insurance.
However, even where there is no contractual PILON clause, HMRC may still require part of the termination payment to be treated as taxable notice pay. This is where the post-employment notice pay (PENP) rules become important.
Post-Employment Notice Pay (PENP)
The post-employment notice pay (PENP) rules are designed to ensure that payments relating to an unworked notice period are taxed as earnings.
In simple terms, HMRC will look at whether the employee has received value for notice that they did not work. If they have, that amount may be treated as taxable employment income.
How PENP is calculated
PENP is broadly calculated by reference to the employee’s basic pay, the length of the notice period and how much notice has already been worked.
The calculation can be complex. This is especially true where the employee has variable pay, receives benefits, is paid in instalments, or has a settlement agreement that includes several different payment types.
If the PENP calculation is wrong, the employer may under-deduct tax. This can lead to HMRC challenges and additional liabilities.
The £30,000 exemption
The £30,000 exemption can apply to qualifying termination payments. This means the first £30,000 of a genuine compensation payment may usually be paid tax free.
However, the exemption does not apply to every payment made when employment ends. Payments for salary, holiday pay, bonus, contractual PILONs, restrictive covenants and post-employment notice pay are generally taxed separately.
Amounts over £30,000
Where a qualifying termination payment exceeds £30,000, the excess is usually subject to income tax. Since April 2020, the amount above the £30,000 threshold can also attract employer Class 1A National Insurance.
This makes it important to separate each part of the termination package before payment is made.
Statutory redundancy pay and settlement agreements
Statutory redundancy pay is usually treated as part of the termination payment. It can normally fall within the £30,000 exemption, provided it is genuinely paid because the employment has ended by reason of redundancy.
Enhanced redundancy payments may also fall within the exemption, but the full package still needs to be reviewed carefully.
Settlement agreement payments
A settlement agreement often includes several payment categories. For example, it may include notice pay, holiday pay, bonus, compensation, legal fees, benefits and sometimes a payment for a restrictive covenant.
Each element should be identified clearly in the agreement. This helps both parties understand which payments are taxable and which may qualify for tax-free treatment.
Restrictive covenants and other taxable payments
A restrictive covenant may prevent a former employee from competing, contacting clients or approaching staff for a set period after leaving.
If a payment is made in return for agreeing to a restrictive covenant, that payment will usually be subject to tax. It should not usually be treated as part of the tax-free termination payment.
Holiday pay, bonus and earned income
Final salary, accrued holiday pay, bonus payments, commission and other earned amounts are normally taxed as employment income.
These sums are usually subject to tax and National Insurance through payroll, even if they are paid at the same time as a wider termination package.
Need advice on a proposed payment?
Speak to our tax and employment law specialists before the agreement is finalised or the payment is processed.
Chartergates’ four pillars of service
Complete
We advise, draft and represent our clients, providing support from initial review through to a successful conclusion.
Commercial
We make the law work for our clients and provide advice that reflects the practical realities of their business.
Confident
Our tribunal experience allows us to provide informed and up-to-date advice from the frontline.
Co-operative
We work closely with clients and their advisers to protect them from HMRC and changing employment legislation.
Get clear advice before the payment is made
Incorrect treatment can expose an employer to additional tax, National Insurance, interest and penalties. Speak to Chartergates before finalising the settlement or processing the payment.
Termination payment tax questions
Common questions about notice pay, compensation, redundancy and the £30,000 exemption.
No. Salary, holiday pay, bonuses, PILON, PENP and restrictive covenant payments may be taxed separately. The exemption generally applies only to qualifying termination payments.
Contractual PILONs are generally treated as earnings. Non-contractual arrangements may also produce taxable notice pay under the PENP rules.
PENP broadly represents the amount an employee would have earned during any unworked notice period. It is generally treated as taxable employment income.
Statutory redundancy pay can normally fall within the qualifying termination payment and count towards the £30,000 threshold.
Qualifying amounts over the threshold are normally subject to income tax and can attract employer Class 1A National Insurance.
Ideally, the payment structure should be reviewed before the settlement agreement is finalised and before the payment is processed through payroll.
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